The bank sells the loan to the collection agency for less than the full, original amount owed. The collection agency then tries to collect the full, original amount owed from you. The difference in amount between what the collection agency gets from you, and what it paid the bank, is the collection agency's profit.
Once the bank sells the loan (it's called "selling the paper") to the collection agency, the bank is out of the picture... that is, unless it goes to trial and either you or the collection agency gives the bank a subpoena forcing it to either produce documents to the court, or show up to testify, or both. Even then, though, the plaintiff in such a lawsuit would not be the bank. At that point, it would be the collection agency. And believe me, the collection agency will be
much more difficult to work with than was the bank!
Once the collection agency buys the paper from the bank, it will contact you and inform you, in writing, that it is trying to collect a legal debt. Said notification must contain certain language, and must notify you of precisely what's owed, to whom, why, etc. Everything the collection agency does is governed by the
FAIR DEBT COLLECTION PRACTICES ACT... a federal law which gives you certain both rights and responsibilities. It sets forth procedures by which you may challenge the debt within a certain number of days of being notified of it; at which point the collector is lawfully obligated to do certain things in response, also within a certain number of days. You may also demand that the collector not contact you by telephone (though it may still contact you by US mail); and there are certain other hoops through which you can make the collector jump.
In the end, though, if the collector is good at its job, you will not escape paying at least something on the debt. Ultimately, the collector will finally sue you. If it wins (and, if it's a legitimate debt, it will), then, ultimately, it will either get the money from you after you've been ordered to pay it by a judge; or it will get said judge to garnish your wages, or put a lien on your home, etc.
Collection agencies will always talk tough and act like they'll only accept the full amount due (usually with interest and other charges which may or may not be lawfully added, depending on what state you live in, and what where the terms of the original agreement between you and the bank). However, most collection agencies will, eventually, negotiate a reduced amount... especially if you can pay it all at once, and early in the game. If not, then the collection agency's attorney -- if not the national lawfirm to which the debt is ultimately referred for legal action, then the local attorney in your town retained by said national lawfirm to file the action -- will negotiate a quick-and-dirty deal to keep from going to court.
Your best bet is to not ignore this situation; to make sure that you understand your rights under the law, exercise them, and deal with the situation properly. Paying off the debt somehow -- and sooner than later -- will probably be better and cheaper. But, then again, it depends on how old is the debt, and what are certain other circumstances. Sometimes collection agencies purchase very old debts from other collection agencies. In the years since you originally incurred the debt, the original documents supporting the debt may have been stored or even destroyed by the entity to which you originally owed said debt. In such cases, simply exercising your right to deny or question the debt, and to demand, within 30 days of being notified of it, full documentation and proof of said debt from the collection agency, will sometimes make the whole thing just up and disappear.
In any case,
talk to a lawyer! Don't get legal advice on something this serious in a place like this. How to pay, if to pay, or whether to file bankruptcy to protect your assets... all of these things are best decided with the help of good legal counsel. Indeed, you should read-up on it, and learn about it, but you should ultimately talk to a lawyer... and sooner than later.
You will also have problems, now, with your credit rating. Once a debt is turned over to a collection agency, it gets reported to TRW, Equifax and other credit reporting companies.
There are many web sites that will give you good information on your options. There are ways to minimize the damage to both your credit rating, and your pocketbook, without filing bankruptcy. Some of that information is out there, on the web... but by all means, ultimately, get the final advice upon which you actually act from a lawyer.